ECONOMY: Major Reforms

Foreign Currency Liberalization

The New Israeli Shekel (NIS) is now a "hard" currency, traded freely on all international money markets. This is a comparatively recent development after decades of currency control, which was essential - as in many countries after World War II - for the survival and growth of the economy.

The severe shortage of foreign currency in the first years of the state was due mainly to its imports being so much larger than its exports. This called for the "rationing" of foreign currency - allocating it only for very basic requirements (such as food, fuel, and defense equipment). Production machinery and raw materials were added to the list only later on, followed by a meager $10 allocation per person for travel abroad.

By the end of the 1950s, import of many "luxury" goods was allowed, and Israelis were allocated $100 per voyage abroad. The 1960s saw a further relaxation of import restrictions, and they were liberalized completely in the 1970s (transferring the onus of restricting imports to the "Chinese walls" of exorbitant customs duties). These, too, were lowered considerably, due to the free trade agreements with the European Union and the United States; and in the 1980s were coupled with a gradual rise in personal foreign exchange allocations for traveling abroad, from $500 to $3,000. The first permits for holding foreign bank accounts and investments followed suit, and in the second half of the 1990s the last bastions of foreign currency control were removed.

The Rate of Exchange

The rate of exchange of the shekel is now, after removal of all foreign currency restrictions, determined by the international money market. This was not always the case. As in all post-WWII economies, Israel's currency exchange rate was a fixed one, changed (devalued) by government decision from time to time.

In 1948 the Israeli lira was equal to one pound sterling (then $4 US); it was devalued to $2.80 in 1949 together with the pound. Since then Israel's currency has been devalued many times (e.g., to 1.80 lira per dollar in 1954, IL3 per dollar in 1962, IL4.20 in 1971 and IL6 in 1974). This, in accordance with the economic policy, aimed at narrowing the gap between the smaller exports and imports, and actually compensating foreign trade for the accumulated local inflation rate since the previous devaluation.

In 1975 Israel followed the change of trend in the OECD and embarked on a "creeping devaluation" (allowing up to 2% devaluation per month). This system lasted two years, until the first step of liberalization was carried out. Since then, the rate of exchange has been determined daily by the Bank of Israel, in accordance with market fluctuations. In 1980 IL10 were converted to 1 shekel and in 1985 1,000 shekels became a New Israeli Shekel (NIS). In July 2007 the NIS rate of exchange averaged $0.24.

Restraining the National Budget

The unusual circumstances of Israel's economic growth, most of which had to be instigated by the government during the first decade or two of statehood, placed it high on the list of countries with a large national budget compared to their GDP. There were instances when the budget was even higher than the GDP, but it was reduced to 95 percent in 1980, to 64 percent in 1990, to 49 percent in 2005, and around 40% in 2006. Also, whereas in the early years a budget deficit (the part not financed by taxation and local loans) was allowed only for "development" (i.e., investment) purposes, later on, with the growing burden of defense, "ordinary" budget deficits became a matter of routine.

During the 1990s emphasis was put on curtailing these deficits. The target was to bring down the deficit/GDP ratio to the rate prevailing in Western developed economies, a policy that was indeed successful in reducing it down to a quarter of what it was at the beginning of the decade. After it rose considerably in 2001, it was brought down to 6 percent in 2003, 5 percent in 2004, 3.2 percent in 2005, and 1.8% in 2006.

The economic reform program embarked on by the government in 2003 continues to reduce the budget (as well as taxes) further and streamline the economy.

Privatization

Whereas the government is still obligated to encouraging economic initiatives, its policy succeeded - since the 1990s - in reducing its direct involvement in the economy. Thus, apart from almost eliminating subsidies supporting the prices of basic commodities and trimming down the entitlement for those directed at encouraging foreign investments and exports, it embarked on a major privatization campaign of selling the ownership of hundreds of public companies.

While during the first decade of this policy many smaller concerns were privatized, the process has been enhanced in the last couple of years, fetching an income of $3 billion from the sale of much larger enterprises like banks, El Al Israel Airlines, Zim (navigation), and Bezeq (communications), with the oil industry being next on the agenda. The government also intends to transfer certain of its services to the private sector.